When completing Schedule M$-2$ for a partnership: $1.$ begin with the partners' outside basis balances as of the end of the prior year, $2.$ begin with the partners' tax capital account balances at the end of the prior year, $3.$ include on line $3$ the net income per the partnership income statement less any nondeductible expenses, $4.$ include on line $7$ any reductions due to differences in the depreciation for book vs tax purposes